- A basis point (or bps or “bips”) is a fractional unit of a percentage
- In value, it is equal to 0.01 percent (one-hundredth of a percent) or 0.0001 in numerical/decimal form
- Basis points are often used to denote changes in yield or interest rates
- Basis points help in curbing confusion regarding the relative and absolute expression of interest change
What are Basis Points?
Basis point (or bps or “bips”) is a fractional unit of a percentage. In value, it is equal to 0.01 percent (one-hundredth of a percent) or 0.0001 in numerical/decimal form. Basis points are often used to denote changes in yield or interest rates.
Conversion between percentage and basis points
The conversion rate of bps and percentage is:
100 bps = 1%
In order to convert basis points into a percentage, divide the points by 100
In order to convert percentage into basis points, multiply the percentage by 100
So, if we say 30 basis points, we will mean 0.30 percent.
For example, if the federal reserve boosts the interests by 120 BPS, it means interest rates have increased by one percentage point.
What instruments use Basis Points?
Basis points are used in the context of many financial instruments such as:
· Corporate bonds
· Credit derivatives
· Treasury bonds
· Interest rate derivatives
· Options and futures
· Debt securities
· Equity Securities
Use of Basis Points
Basis points are used to denote small changes and are especially relevant to financial measures. The smaller the numerical change, expressing it on a basis point is easier to state than state the change in percentage.
So, we can even go smaller with basis points and talk of say, 3 basis points, to indicate a change of 0.03 percent change. Basis points come in handy when describing changes in interest rates, for example.
Basis points also avoid ambiguity when discussing absolute and relative interest rates. For example, if an interest rate increases from 11% to 12%, some people may use the absolute method to express it and say that there is a 1% increase in the interest rate. In contrast, some one else can use the relative method and say that there is a 9.09% increase in the interest rate. Basis points help in curbing this confusion by saying the interest rates have increased by 100bps.